This week, I’m thrilled to welcome back a very popular guest, Cameron Skinner, to the Option Alpha podcast. Way back on Show 61, Cameron and I talked at length about his consistent and religious process for trading options–even though his “day job” as a real estate investor takes the majority of this focus and attention. Well, Cameron is back for another interview, and this time we dove even deeper into his strategies and how he thinks about risk and the markets. Please enjoy our follow up conversation with Cameron Skinner.

Common Themes in Questions Cameron Gets Asked About Trading:

Being flexible:

• A lot of people who get into options trading have an engineering mindset. Cameron has spoken before about going out two standard deviations, about 10% out-of-the-money, to initiate trades during normal environments. If volatility spikes, that ~10% out-of-the-money, two standard deviation level for entry changes. In engineering, everything sticks to a plan, like building a plane. You have to follow the instructions meticulously. In trading, these types of thinkers say, for example, “Well, that’s not 10% out-of-the-money. It’s 8%.”
• Trading options is more like running a business. You’re not putting a plane together where everything has got to be perfect. You have to have some flexibility with your trading to tailor to changing markets.
• To a certain degree, you have to be rigid with your strategies, but there has got to be a little bit of flexibility, like a tree moving in the wind.

‘How much can I make? How much can I do?’

• People say, “Cameron, I did exactly what you said to do, and I did it for five contracts and two trades did not work out.” Or, “How much can I make following your strategy?”
• Cameron can tell you what he has done in the past, but always ends every answer with, “This has worked in the past, but with different market conditions and with different option pricing. This strategy may not be profitable in the future.”
• For example, if you say to someone, “Go out to around a 5 delta, or around a 10 delta,” the choice between each is going to be dictated on what liquidity looks like. Maybe the 10 delta is $5, and the 5 delta is $4. Why would you need to go all the way out to the 5 delta and save a dollar, when you could just easily accomplish the same thing at the 10 delta for a dollar more?

Flexible Trading By Treating It Like A Business

• Like Cameron says, options trading is like running a business more than being an engineer. If you sell Camaros, you will have experience knowing when you are getting a good deal no matter what market you are in. Trading options is similar – they’re contracts and the pricing is very fluid. You need to learn options and understand them. You cannot just follow someone’s system and feel that you’ll be profitable over the long-term. So, even though engineering types gravitate toward options trading, their ‘never deviate from the plan’ training is not fitting.
• You need to set up a strategy with a large number of similar occurrences. Then, you get that strategy going as if you’re buying and selling your Camaros. You get familiar with that strategy, when it is profitable, and when to tweak it.
• Once you get familiar with that strategy, you can add a new on, like go into Corvettes.

Set Up A Trading Plan and Write It Down

• A lot of people are vague about how they will respond to a certain market condition. When things start going crazy, like when COVID hit, you’ve got to have a clear plan in place and stick to it, because if you do not, you’ll make emotional decisions.
• This is harder than it seems. This is what setting up an auto trading strategy on the new platform will require, though. Most people are like rabid animals when they go into the market, looking for anything to kill. It is far wiser to go in with a clear idea of what you are after and then be flexible with the implementation.
• When you set up that trading plan, make sure that it’s reasonable – do not go in looking for a 100% return. You can make huge returns on options, but the risk-reward on those cases does not add up. ‘You can also make a lot of money in lottery tickets, but that does not mean they’re a good investment.’

Why People Still Believe They Can Achieve 100% Returns When It Is Not True

• There is a lot of false promotion out there. After COVID hit, many sports gambling YouTube channels switched their content to options gambling. Rare cases where people win big get shared on social media. There is the lure of easy money with little work.
• In contrast, Kirk and Cameron are trying to teach people to use options as an investment strategy, not speculate or gamble. You need a large number of similar occurrences, you need low position sizes within those separate strategies. You need a lot of tools in your tool belt to handle different market conditions. You need to be careful not to over-leverage and then speculate because a quick move in the market will stomp you out.

How to Get A Large Number of Common Occurrences

• You need to set up a consistent, mechanical strategy, so you get that large number of similar occurrences, instead of chasing Tesla this week, and chasing eBay next week, because that’s when you roll into speculation. When you move into speculation, eventually, you’re going to lose to the platforms and lose to the market makers because of the bid-ask spread.

Cameron’s Core Strategy

• Kirk often uses Cameron as a reference because of his consistency and the repetitive nature of his strategy. Also, because he has a very high level of activity on a general basis.
• For example, you sell a credit spread at about 10% out of the money. Traditionally, your best decay when you’re 10% out of the money is 60 to about 25 days. So at about 60 days out, let it decay down to 30 days. As our options march to that strike date, when you’re out of the money, they decay. If they hit the short strike, Cameron takes them off, because once that credit spread is in the money, then decay starts working against him. He is constantly scaling into that next credit spread, which is farther out of the money, starting another decay.
• To this, Kirk asks, “If you take one-off, do you put one on at a further strike out?”
• You can. You can roll it out and that goes back to your trading plan. When you go to your trading plan, that’s what you need to ask. Let’s say you’ve got to take three off because they hit the short strike. Then you say, “Do I just roll out one, or all?” That would be part of your trading plan. Cameron takes them off as soon as they hit the short strike and then adds one a day. Then he ends up with a little extra capital in his account. When things settle down, he scales back in.
• That strategy needs to be set up so that it’s a reasonable return on investment. Warren Buffett became one of the richest men in the world through only making a 24% return on investment but doing so consistently. And Buffett has gone through, at times, decades of underperforming the market. Do not try and make a 100% return on options. Try and set up your strategy, so it’s reasonable.

How to Weigh Your Core Strategy with Other Strategies

• Cameron sets up his core strategy using the Kelly criterion and allocates about 60% of his capital to the core strategy and never goes over 70% of his account value using it. He uses 10% or 15% of his account to do some more aggressive and flashy stuff that helps keep his attention.

How to Know If Your Plan is Working or Not, and When To Throw It Out

• This goes back to the airplane versus business analogy. You have to look at the factors that might be influencing your plan to know whether it is the factors or the plan to blame. Is your strategy not working due to market conditions?
• If you’re in normal market conditions and you’re not getting a good return on the strategy, then that’s when you need to either tweak it, throw it out, or revise it.
• Cameron has a trading plan, which is a core strategy in normal market conditions. He has a trading plan when VIX spikes, with a completely different trading plan, bolted on top of that to take advantage of VIX.

Cameron’s VIX Trading Plan

• He does credit spreads just outside of where VIX is trading and tries to go 45-90 days out, and then just waits for the VIX to collapse. Then he scales into that.
• This is similar to Larry Connors’ VXX strategy. When it spikes, he does a stair-step progression of scaling into the strategy as it continues to move up.
• This goes back to having a plan where you know how to act as conditions change. If the VIX spikes to a certain level, you do a credit spread A wide at B% of your account value. Then, if it goes up to C more, you use D% more of your account value.

Learning from Real Estate

• If you understand real estate and your asset of choice is rentals, you know that buying a property at X and renting it for Y is a good strategy, and that rentals can be profitable. This does not mean that you buy every rental on the market. Your game plan incorporates decision making based on current conditions.
• If you find a property that can give you X rent a month, how much would you pay for it, and what is the risk? That is how you should look at options.
• Also, you will not hear real estate experts saying rentals are trash if they bought a rental, and then it flopped because of COVID. They understood that the cause was an exterior condition, not the strategy itself.
• Real estate strategies involving speculation, such as buying land, typically do not make as much as those that generate consistent income. It is the same with options trading.
• There are many similarities between real estate and options trading. A covered call is just renting out your stock with an option to purchase.

Keeping A Trading Log

• If you do not keep a trading log, it is hard to keep track, especially if you’re running multiple strategies. You need to keep a trading log on each individual strategy you’re running because otherwise, you do not know if you’re profitable.
• The only way you’re going to know which options strategies are your most profitable is if you keep a good trading log.

The Rise in Speculation

• The availability of platforms coupled with incredibly low commissions has brought so many new participants to the market. There’s no barrier to the market these days, which is great, but it has allowed people to speculate much easier than they would have otherwise.
• People only end up hearing about big wins, and losses that are not publicized could have been made using the same strategy.

Final Words From Cameron:

• Set up a strategy, write it down, and stick to your trading plan–as long as it is working. You’ve got to keep a trading log to know what is working and know how profitable it is.

Option Trader Q&A w/ Anonymous

Trader Q&A is our favorite segment of the show because we get to hear from one of our community members and help answer their questions live on the air. Today’s question comes from Anonymous:

Hey, Kirk. I’m just researching the sizzle index on thinkorswim and I’ve been looking around your YouTube and your website and have noticed that – at least I couldn’t find, but I’ve noticed that you haven’t published much about the sizzle index and was just seeing if you’ve used that and then how you think about it, or if you stay away from it. All right, thanks.

Remember, if you’d like to get your question answered here on the podcast or LIVE on Facebook & Periscope, head over to OptionAlpha.com/ASK and click the big red record button in the middle of the screen and leave me a private voicemail. There’s no software to download or install and it’s incredibly easy.